Description

Manatron is a consistently profitable 30-year old software company with an $18.5 million market cap. The company has about $9.5 million in cash and investments, no debt, and has generated over $10 million in free cash flow in the last six quarters. In addition, I believe the large investments the company has made in its software systems over the past six years ($31 million in R&D plus $5 million for two company acquisitions) are now paying off in growing business momentum and improved profitability. Possible catalysts include improving business fundamentals, share buybacks (and potentially a tender), and increasing profit margins as the company rationalizes its product portfolio. A final catalyst is pure valuation, since MANA is currently trading at little more than 2.5 times trailing free cash flow.

Business Description

Manatron is a 30-year old company that specializes in providing software and services to support local government processes, including accounting, tax, real estate appraisal, record archive and retrieval, mapping, billing, judicial and court processing, and e-commerce. Manatron has a huge customer base of over 1,600 clients in 31 states, 390 counties, 250 cities, and 300 townships, and three Canadian provinces. The company also has a strong barrier to entry due to the sheer effort and time required to build such a customer base, and the high switching costs required for these customers to switch vendors. Also, MANA specializes in keeping its software in compliance with the various requirements of state statutes and local government regulations, and this specialized expertise also represents a competitive barrier.

In addition to software sales, MANA also provides the normal ancillary services, which include hardware integration and maintenance, software support, project management, implementation, consulting, training, etc. MANA provides these services through regional offices located in regions where it has a sizable customer base. Currently the company has regional offices in Florida, Illinois, Indiana, Michigan, North Carolina, Ohio, and Pennsylvania. In addition to its software and related services business, the company also provides mass property appraisal services through its Sabre Appraisal division, which assesses residential, commercial, and other property values for city and county tax authorities.

MANA has a market cap of $18.5 million at the recent stock price of about $4.60.
The company has $8 million in cash and short-term investments and no debt. MANA also allows installment payments for software sales to some of its long-standing government clients, mostly in Illinois. The company typically finances purchases for three-to-five years, for which the company receives debt notes carrying interest at anywhere between 8 and 10%. The 10-K notes that MANA has “a longstanding history of collecting on the notes under the original payment terms”. At October 31, MANA had $1.2 million in current notes receivables on the balance sheet and $250K in non-current notes receivable.
So if you count the notes receivable, there’s about $9.5 million in cash and investments on the balance sheet.

MANA has generated $13.2 million in operating cash flow and $10.3 million in free cash flow (defined as OCF – CapEx – Capitalized software) on revenues of about $60 million in just the past six quarters.

Allen Peat and Randall Peat are brothers and co-founders of the company. Randall Peat owns 11% of the stock, Allen Peat owns 7.6%, and J.Wayne Moore, who was the owner of ProVal, owns 8.6%. Current CEO Paul Sylvester owns 3.8% of the stock. Altogether, directors and officers own 41% of the stock.

Notable Improvements in the Business

Manatron has been making great strides in building the long-term value of its business over the past year and a half. For one thing, the company is investing heavily to take market share and become a true end-to-end provider of software and IT solutions for local governments, which is a highly fragmented market. The company has invested more than $27 million in software research and development over the five fiscal years of 1997-2002 (MANA’s fiscal year ends in April).

MANA has specifically invested most heavily in three software systems – MVP Tax and MVP Tax Manager, which is a fully integrated tax billing and collection system, ProVal, a leading computer-assisted mass appraisal (CAMA) system, and GovernMax, which is a suite of internet-related products that helps local governments move many of their resident transactions online, anything from property tax, government utility, and parking ticket payments to court schedules and record access.

Major new contract wins in fiscal 2002 are evidence that the company’s heavy investments in its software systems are paying off. The company signed more than $10 million in new contracts with sixteen counties in the state of Florida, mostly for MVP Tax Manager. Manatron also signed the biggest deal in its history, a $5.3 million contract for MVP Tax and PropertyMax in Ohio, and also landed a $2 million deal in Alabama for MVP Tax Manager.

The company’s strategy is to dominate individual states in which they have a foothold in order to achieve economies of scale. MANA has clients in 85 of the 92 counties in Indiana, for example, and 66 of the 88 counties in Ohio. Recently, the company has made a strong move into Florida and now serves 32 of that state’s 67 counties.

Historical Financials

Manatron is a historically a consistently profitable and cash flow positive company.
Manatron’s revenues grew from approximately $10 million in fiscal 1992 to $11.9 in fiscal 1993. Acquisitions boosted revenues to $18.2 million in 1994 and $24.7 million in fiscal 1995. Revenues declined slightly in 1996 and 1997 due to the low part of the mass appraisal cycle, but began to grow again in fiscal 1998, and jumped to $37 million in fiscal 1999. The company generated positive free cash throughout the 1990’s, and was profitable on a GAAP basis for most every year except 1996. The company’s annual free cash flow topped out at $5.4 million in fiscal 1999 before hitting two poor years (fiscal 2002 free cash flow was around $8 million.)

In looking at the past six and a half years, the company has generated $23.5 million in operating cash flow and $12.8 million in free cash flow, or about $3.6 million in OCF and just under $2 million in free cash flow annually. However, the past six and half years include two years that are uncharacteristically poor for Manatron, those being fiscal 2000 and fiscal 2001. Excluding those two years, the company has averaged $6 million in operating cash flow and $4.5 million in free cash flow, numbers that I believe are more indicative of Manatron’s true cash generating ability. It is notable also that the company has managed to generate decent free cash flow even after investing heavily for future growth – in the same six and a half years, MANA has spent $31 million in research and development and made two acquisitions for $5.1 million, which has helped to grow revenues from $22 million in fiscal 1997 to $41.1 million in fiscal 2002. The chart below shows revenue, cash flow, R&D, and total cash and debt figures for the past six fiscal years and the first two quarters of fiscal 2003.

YEAR* REV OCF FCF+ R&D CASH DEBT
1997 $22.0 $2.9 $2.0 $3.1 $0.5 $1.6
1998 $24.8 $3.9 $2.4 $4.3 $1.6 $0.4
1999 $37.5 $7.1 $5.4 $4.8 $6.5 $0.2
2000 $43.7 $-0.9 $-3.6 $4.4 $0.6 $1.1
2001 $41.1 $-2.8 $-3.7 $5.0 $0.7 $3.6
2002 $41.1 $9.9 $8.1 $5.8 $5.6 $0
Q1 '03 $ 9.5 $2.1 $1.6 $1.6 $7.3 $0
Q2 '03 $ 9.7 $1.2 $0.6 $2.0 $8.0 $0

* Fiscal year ends in April
+ FCF is defined as cash from operations minus net additions to property and equipment minus capitalized investments in computer software. Cap-ex in 2000 was $2.3 million due to the purchase of the company’s HQ building for $1.3 million.

Manatron has made nine acquisitions in the last decade, though only five of those have been of material size. The first, the 1992 purchase of Specialized Data Systems of Greenville, NC, was a $1.2 million dud. The company had about 400 customers of its low-cost accounting and tax software, mostly in Southeast, and wasn’t profitable.

In 1993, Manatron found better value in buying the assets of ATEK Information Services out of bankruptcy for $740,000. ATEK was then a 25-year-old software company with offices in Canton, Ohio and Indianapolis, Indiana, and had been Manatron’s largest competitor in those two states during the prior 10 years. This deal therefore strengthened MANA’s market share in those two states. The acquisition had one other accounting benefit, that being a big tax savings due to a $2 million uncollectible note that was on ATEK’s balance sheet at the time of the purchase. The subsequent write-off saved MANA about $700K in taxes, which basically paid for the acquisition.

Manatron then spent $3.9 million in late 1994 to buy Sabre Mass Apraisal Services, one of the largest mass appraisal vendors in the United States. In addition to appraisal services, Sabre’s real estate appraisal software was a competitor of Manatron in Ohio, where Sabre had some 25 counties as software clients. The acquisition extended Manatron’s market share lead for real estate appraisal software in Ohio. However, the Sabre acquisition brought some cyclicality to the business, since the company’s core mass appraisal market (Ohio) runs on a regular six-year appraisal cycle for property tax purposes. In other states, property re-appraisals are highly politicized events usually done on an ad-hoc basis, making the business very lumpy from year to year. In April of 1998, the Sabre division landed a $24 million re-appraisal contract with Allegheny County in Pittsburgh, PA, which will be discussed in more detail later.

Manatron didn’t make another major acquisition until June of 1999, when it bought ProVal, a 26-year old software company headquartered in Springfield, Ohio. ProVal specializes in computer-assisted mass appraisal (CAMA) software, and had an installed base of approximately 150 jurisdictions in 16 states and three Canadian provinces. ProVal’s revenues at the time of acquisition were approximately $1.5 million. MANA paid $1.5 million in cash and issued 300,000 shares, worth $3.45 million at the then-price of about $11 per share. Additional stock was issued for earn-out targets in 2000 and 2001 that totaled about $500K in value. ProVal was basically a buy-versus-build decision, since MANA had identified the need to develop a Windows-based property tax and appraisal system to replace its legacy systems. ProVal already had a marketed Windows-based system with all the features Manatron wanted to build, and ProVal was also a major MANA competitor for appraisal software in Indiana. Importantly, ProVal’s product also has features that make it applicable nationwide, while Manatron’s systems were state-specific. At the time of the acquisition, ProVal’s revenue run-rate was about $1.5 million, which has grown to about $3 million of profitable, recurring revenue today.

In 2000, Manatron purchased assets of CPS Systems out of bankruptcy for $1.8 million. CPS had marketed a Unix-based tax manager system, primarily for Florida and Oklahoma, called Classic Tax Manager. CPS had some 35 county customers for the software in Florida, representing recurring annual revenue of about $2 million. MANA recently introduced MVP Tax Manager, a Windows-based version of Classic Tax Manager. The CPS acquisition has been a good one, with former CPS clients now accounting for some $3 million in yearly revenues. In addition, the deal helped MANA to achieve a heightened presence in Florida, which has led to recent new software sales that are among the biggest in company history.



Manatron suffered two uncharacteristically cash flow negative years, in fiscal 2000 and 2001. The 2000 fiscal year’s reported earnings looked fine, as the company achieved record total revenues of $43.6 million and reported a profit of $1.6 million, or $0.45 per diluted share. However, the cash flow statement told another story, with negative operating cash flow of $862K and negative free cash flow of $3.5 million. The operating cash flow deficit was due to a multi-year, $24 million property reappraisal contract in Allegheny County, which was the largest in company history and one of the largest ever in the mass appraisal industry. The company’s accounts receivable balance associated with the performance of this contract ballooned by over $3 million dollars in 2000, hurting cash flow. In addition, in fiscal 2000, MANA purchased and furnished a new headquarters building, at a cost of $1.3 million, causing capital expenditures for the year to total $2.3 million, well in excess of its normal annual capital-ex range of $400-700K.

Fiscal 2001 was just a plain down year, as several factors combined to cause a net loss of $940K, negative operating cash flow of $2.8 million, and negative free cash flow of $3.7 million. First, there was a hangover from the heavy spending the previous year, as many of the company’s local government software customers didn’t upgrade systems because they have invested significant resources in bringing their IT systems into Y2K compliance in 1999 and early 2000. Additionally, many government officials that make capital spending decisions put off new system purchases during election years, when they are pre-occupied with campaigns. MANA software revenues are therefore historically somewhat softer in election years, and the Y2K effect magnified this phenomenon in fiscal 2001. Finally, the Allegheny contract, which had accounted for some 19% of total fiscal 2000 revenues, was winding down, accounting for only 11% of total 2001 revenues. In addition, the company was still running a very high accounts receivable balance to the county, thereby hurting cash flow. Eventually, there was a legal battle between Manatron and Allegheny County, which Manatron eventually won.

The company also had probably gotten overstaffed during the growing years of 1998-2000 along with the process of integrating the ProVal and CPS acquisitions – the company had 462 employees in fiscal 2000, a number that has been significantly reduced in the past two years (there were 362 employees as of the most recent fiscal year-end.)

The Appraisal Business

Sabre is one of the largest mass appraisal vendors in the United States. Mass appraisal engagements are typically performed at a fixed price contract over an 18-24 month time period. Mass appraisals are performed through a combination of physical inspection, computer analysis, and professional appraiser estimates to assess a value to each parcel of property in a given jurisdiction, which are then compiled for tax purposes.

The real estate services act as a product extension for Manatron, as many of Manatron software customers also periodically use mass appraisal services. Allegheny County accounted for 11% of 2001 revenues and 19% of 2000 revenues, but less than 1% in 2002.

Unfortunately, in addition to being cyclical, the mass re-appraisal business is also highly contentious and often litigious. While Sabre can count on solid, recurring revenue every six years from its Ohio clientele, the politicized nature of the process in other states can make it very interesting. The Allegheny County contract was apparently necessitated by a court ruling in the county, and both the re-appraisal and the payment for Sabre’s services was contested by certain county officials. Eventually, the county controller filed suit against the company for failure to perform and breach of contract, a suit that was dismissed without prejudice in April of 2002. Another suit was filed in 2002 by the town of Branford, CT contesting payment on a $538,000 contract. Since Branford has rejected and prevented Manatron’s attempts to remedy the conditions the Branford alleged were in default under the contract, MANA has filed a claim for breach of contract and is seeking to recover the remaining $220K due under the contract.

Given the contentious nature of some of its recent mass appraisal contracts, CEO Paul Sylvester has noted that the company will confine its appraisal business efforts to its traditional market areas, primarily Ohio, where it has been most profitable. CEO Paul Sylvester believes that the appraisal division acts as a strong conduit to software sales in Ohio, and thinks that over a full cycle the appraisal business should average $10 million in revenues and throw off $1 million in pre-tax cash flow annually. If Sabre is able to re-sign previous Ohio appraisal clients from the last cycle, appraisal revenues should begin to increase in 2004 as the new six-year cycle starts.

Catalyst

• Aggressive share buyback program – the company has authorized a $500,000 share buyback. Previous share buybacks have not been aggressively pursued, but CEO Paul Sylvester has indicated that this will be a higher priority.

• Efficiencies achieved by rationalization of the software product portfolio. MANA currently supports over 200 systems, both current and legacy. Sylvester has a stated goal to methodically rationalize its product portfolio, which may involve divesting some products, discontinuing products, aggressively migrating customers to current products, etc.
• Continued positive cash flow – No company can continue to trade at under 3 times free cash flow for long. If MANA keeps generating cash, the stock price will eventually move up.
• Expanding profit margins as software revenues become a larger piece of revenue – the software businesses are growing and profitability should therefore increase as more revenue is spread over a relatively fixed cost base.
• Begin of upswing in appraisal business as new cycle begins in 2004 – The appraisal business, which basically breaks even during down years, should begin contributing meaningful profits beginning in fiscal 2004.